UNIVERSITY COLLEGE OF THE CARIBBEAN

COURSE CODE AND NAME: ACT 205 – TAXATION THEORY & PRACTICE
LECTURE TITLE: TAXATION THEORY
LECTURE NUMBER: 1 /UNIT 1

Welcome to our first class in Taxation Theory and Practice. A sound knowledge of taxation in general and
the Jamaican tax system in particular is essential for students who are working in or plan to work in
business or who intend to make a quality input into the decision making process of a business. In today’s
class we will cover several sub-topics under the heading, “Taxation Theory”. The content from Unit 1 will be
covered in one lecture.

The focus of this class is to introduce some of the major concepts that will underpin our study of the theory and
practice of taxation. The class provides a definition of taxation and overviews the generally accepted criteria for
assessing taxation systems. There is also an examination of the structures and types of taxation and an overview
of its economic purpose and importance.

Learning Objectives
At the end of this lecture, you should be able to:
1. Define the term taxation
2. Explain the attributes of a good tax system
3. Outline the main tax structures
4. Discuss the country’s right to tax
5. Explain the economic effects of taxation

Please read the following for this lecture:

 The prescribed text: Mendes, M., McLean, R. A. and Wynter, C. (2013). Essentials of Jamaican
Taxation (4th ed).
 Tax types from https://www.jamaicatax-online.gov.jm/tax_types.html
 http://www.slideshare.net/fimportado/general-principles-of-taxation?next_slideshow=1
 http://dx.doi.org/10.1787/9789264218789-5-en

1.1 What is Taxation?

We are all familiar with the concept of taxation. It affects us all at all stages of our lives. It affects the students,
the employed, the self-employed and the retiree. We all have to deal with the tax system, whether it is paying
taxes on our purchases (GCT), paying income taxes, NHT, NIS and property taxes. Have you ever stopped to
think about the meaning of taxation? How would you define it?
“A tax is a compulsory, unrequited payment to general government” (OECD, 1996, p.3). The OECD (1996)
further stated that “taxes are unrequited in the sense that benefits provided by government to taxpayers are not
normally in proportion to their payments” (p.3).
The New Webster Dictionary of the English Language (1993) defines tax as “a charge imposed by
governmental authority upon property, individuals or transactions to raise money for public purposes” (p.
1064).
Cooley (1924) as cited in C. A. Nichols defines tax as "the enforced proportional contributions from persons
and property, levied by the state by virtue of its sovereignty for the support of government and for all public
needs." (p. 61).
The Black’s law Dictionary (2004) defines it as, “Monetary charge imposed by the government on person’s
entities or property, levied to yield public revenue” (p. 1500).
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In the case of Leake v Commissioner of Taxation 1933 WALR Vol. 66, a tax is defined as “a compulsory
contribution, imposed by the sovereign authority on, and required from, the general body of subjects or
citizens”. Imposition is by way of a legislative process and taxation must be for a public purpose.
Now in your own words, define taxation.

Differences Between Tax and Other Government Sources of Revenue

The following is a list of features that distinguish tax from other sources of government revenue.
a. Tax is compulsory
b. Tax is imposed on all subjects
c. Tax is imposed by the exercise of the state’s sovereign power
d. Tax is levied by the ordinary legislative process
e. Tax is imposed for a public purpose (Mendez, Mclean, 2013, p. 7)

1.2 What are the Attributes of a Good Tax System?

In his 18th century publication “The Wealth of Nations”, Adam Smith, noted Scottish philosopher and
economist, suggested the following four principles of a good tax system.
 The subjects of every state ought to contribute towards the support of the government, as nearly as
possible, in proportion to the revenue in which they respectively enjoy under the protection of the state.
 The tax which each individual is bound to pay ought to be certain and not arbitrary. The time of
payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the
contributor and to every other person.
 Every tax ought to be levied at the time, or in the manner in which it is most likely to be convenient for
the contributor to pay it.
 Every tax ought to be so contrived as both to take out and keep out of the pockets of the people as little
as possible over and above what it brings into the public treasury of the state.
These principles are generally accepted today and they have made an important contribution to the set of
criteria widely used to evaluate the tax policies and measures of governments in many different countries.
Let’s examine the list of such criteria as shown below along with brief explanations.
a. Revenue Productivity/adequacy - the primary goal of a tax system is to generate revenues to pay
expenditures of government at all levels. Taxes should produce the right amount of tax at the right time.
b. Impartiality - the system should be fair. As far as possible it should be impartial between one person
and another.
c. Equitability in the distribution of the tax burden - taxpayers in similar circumstances should bear
similar tax burden (horizontal equity) and taxpayers in better circumstances should bear a larger part of
the tax burden as a proportion of their income (vertical equity).
d. Certainty and simplicity - the rules should be clear, simple and easily understood by taxpayers and not
subject to negotiation by taxpayers.
e. Convenience to Taxpayer - it should be convenient for taxpayers to comply with the rules.
f. Consistency with government policy - the tax system should be automatic in stabilising the economy
and it should encourage rather than hinder effort and initiative.
g. Flexibility - the system should be flexible and dynamic enough to meet the current needs of government
and adapt to technological and commercial developments.
h. Effectiveness - the system should minimise opportunities for evasion and avoidance.
i. Efficiency - tax administration costs should be minimised as far as possible.
j. Transparency – taxpayers can easily find information about the tax system and how the money is used..

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1.3 Main Tax Structures
How familiar are you with the tax structure? When applying tax, it can be either proportional,
progressive or regressive. Have you ever heard of these terms? Let us briefly at what they are.

Proportional, Progressive & Regressive

When considering tax structures, it is important to look at income in terms of levels or bands and
determine the extent to which the burden of a particular tax impacts taxpayers in one income level or
income band more than it impacts taxpayers in another income level or income band. The focus is not
simply on the tax rate but also on the percent of overall income paid for that tax by a taxpayer in one
income band when compared to a taxpayer in another income band.

a. Proportional Tax
A proportional tax is a tax for which the percentage of income paid in taxes remains the same at all
income levels. It is often referred to as a "flat tax" because every person pays the same percent of
their income in taxes. For example, a person earning $8 million a year and a person making $800
thousand a year would each pay the same percent of their income in taxes. In Jamaica, the tax rate is
25%. Both the person making $8 million and the individual making $800 thousand a year would pay
25% of their taxable income in taxes. The millionaire would pay more because the gross dollar
figure being taxed would be larger, but everyone pays the same rate.

A graphical representation of Proportional Tax

y

Tax Rate

0 Income x

The rate of tax remains the same as the income increases

Proportional tax structures sometimes contain built in provisions for thresholds below which the rate of
tax is 0% (a nil rate). The purpose of this threshold is to relieve those individuals at the bottom of the
income scale. Jamaica’s individual income tax is an example of a proportional tax with such a built in
threshold. As of January 2015 a nil rate is applied to personal incomes up to $557,232 while the rate of
tax on the income of individuals above this level is 25%. For example, the individual who earns
$800,000 will be asked to pay tax of 25% on the amount of $42,768 ($800,000 – $557,232) whereas the
one who earns $8 million dollars will pay income tax on $7,442,768 ($8,000,000 - $557,232), ignoring
all other taxes.

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 b. Progressive Tax
A progressive tax is a tax for which the percentage of income paid in taxes increases as income
increases. People with higher incomes pay a higher percentage of their income in taxes. People with
very small incomes might pay no tax at all. . Most direct taxes are progressive, e.g. income tax. Jamaica
at one point in time used to have a progressive tax system. The disadvantages here are tax evasion and
disincentive to production. An example of this in recent time was evident when the income tax rates
were adjusted to a higher rate if income exceeded $5M up to $10M. An income tax rate of 27.5% was
applied to earnings between $5M and $10M. If the income exceeded $10M then the applicable rate
would be 35%.

Graphical depiction of progressive tax

Tax Rate

0 Income x

The rate of tax increases as the level of income increases.

Let us use for example a tax that requires a person’s income to be taxed at 10% on the first $600,000, 20%
on the next $300,000 and 40% on the portion above $900,000.
If Adam earns $1,000,000.00 per year the calculation would be as follows.
10% x $ 600,000.00 = $ 60,000.00
20% x $ 300,000.00 = $ 60,000.00
40% x $ 100,000.00 = $ 40,000.00
Total $1,000,000.00 $160,000.00

Percent of Adam’s income paid as tax: $160,000.00 / $1,000,000.00 = 0.16 or 16%

If Moses earns $2,000,000.00 per year the calculation would be as follows.
10% x $ 600,000.00 = $ 60,000.00
20% x $ 300,000.00 = $ 60,000.00
40% x $1,100,000.00 = $440,000.00
Total $2,000,000.00 $560,000.00

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 Percent of Moses’ income paid as tax: $560,000.00 / $2,000,000.00 = 0.28 or 28%
Adam at the lower income level is effectively paying 16% of his income for this tax while Moses at the
higher income level is effectively paying 28% of his income for the same tax. This example of progressive
tax shows that although the tax rates are the same for both persons, the person in the higher income bracket
pays a higher percent of his income for this particular tax than the person in the lower income bracket pays.

c. Regressive Tax
This means that the taxpayer pays a smaller proportion of his income in tax as income increases. This tax
structure which requires the more well-off to pay a lower percentage of their income (or wealth) in tax than
a less well-off citizen. This is a tax which on the surface may appear to be equitable because everyone,
regardless of income, pays the same fixed percentage rate. The reality, however, is that this type of tax
results in the lower-income groups paying a greater proportion of their income than higher-income groups.
They are regressive because they are not based on one’s ability to pay. GCT is an example of a regressive
tax.

Graphical depiction of regressive tax

y

Tax Rate

0 Income x

The tax rate increases as level of income decreases

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 Let’s look at the following example:
Three taxpayers, Matthew, Luke and John earn annual income as follows:
Matthew - $8, 000,000; Luke - $2, 300,000 and John - $800,000.
All three purchased the same refrigerator which cost $250,000, attracting GCT at the rate of 16.5%. The
effective tax on each income is as follows:

Purchase Matthew Luke John

information
Price of item $250,000 $250,000 $250,000
GCT @ 16.5% $41,250 $41,250 $41,250
Income $8,000,000 $2,300,00 $800,000
0
Proportion of tax 0.52% 1.79% 5.16%
paid to income
earned

Direct Taxes and Indirect Taxes

The terms Direct Taxes and Indirect Taxes have been used to differentiate between the class of taxes that are
levied directly on persons including companies and the class of taxes that are levied on objects, goods,
transactions and services that the taxpayer may use, acquire, perform or even avoid.

a. Direct taxes
Direct taxes are taxes on persons and are aimed at a person’s ability to pay as measured by his net
wealth or his income. One example of direct tax is the individual income tax. Individual income tax is
usually levied on a person’s total net worth (the value of his assets minus his liabilities) or on his total
income adjusted to take account of some legal provision. This tax on income cannot be shifted to
another person. It falls on the person whose income is reduced by the tax. Even where the person owns a
business, the tax on the profits of that business may reduce the net income of its owner. Other types of
direct tax are: tax on the profits of companies; Capital Gains tax; Transfer Tax on real estate and on
legacies; and property tax.
b. Indirect taxes
Indirect taxes are usually levied on objects, services and transactions. Examples of indirect tax are:
sales tax on consumer goods; value added taxes; and customs duties. In contrast to direct tax which
cannot usually be shifted to someone else, indirect tax can be shifted, minimised and sometimes avoided
based on whether and to what extent the taxpayer decides to engage in particular transactions. Instead of
paying customs duty on an imported item, for example, a taxpayer may decide to substitute that item
with an indigenous item that is not subject to tax. The ability to shift the tax to another person may even
be built into the legislation as happens with GCT, a value added tax where businesses have the ability to
shift the tax to the consumer. Other examples of indirect tax are: Special Consumption tax and Excise
Duties paid by manufacturers on goods manufactured within a country.

1.4 Purpose of Taxation

The main purpose of taxation is to:
1. Raise revenue for government spending - – This is the Fiscal and Budgetary purpose.
2. Promote stable economic growth – This is the Economic purpose.
3. To promote redistribution of income and wealth – This is the Social purpose.
4. Discourage consumption / production of goods with negative externalities or demerit goods e. g. the
consumption of alcohol and cigarettes.
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 Taxes have also been used for other purposes that might not be easily classified into these three purposes.
An example of this is the use of tax to discourage consumption / production of goods with negative
externalities or demerit goods such as air pollution, alcohol consumption, and smoking.
The challenge that governments have is to reconcile the three main purposes which sometimes seem to
conflict with each other. The level and composition of taxes necessary for budgetary purposes may not be
the level and composition necessary to promote stable economic growth. Similarly, a tax that is structured to
lessen inequalities in the distribution of income and wealth could also have a negative effect on economic
growth.

1.5 Effect of Taxation on the Economy

 Government uses taxation to regulate the economy (Fiscal Policy):
o Contractionary – a fiscal policy used by government when an economy’s growth rate is getting
out of control, which means that it is causing inflation. One way of slowing the growth rate is to
increase taxes. This decreases spending as consumers will have less money to spend and invest.
o Expansionary – a fiscal policy used by the government when an economy is in recession in
order to increase spending. One way of doing this is to lower taxes. This will allow for
consumers to have more money at their disposal to spend or invest.
 Spending by the government and the system of taxation will impact on the economy of a country.
 Taxation policies have been used to influence economic factors such as employment levels, inflation and
imports/exports.
 Taxation policies are also used to direct economic behaviours of individuals and businesses. For
example, they encourage individual saving habits.
 They may discourage smoking & alcohol consumption (duties and taxes).

Lecture Summary
 A tax is a required payment to a government, local or central government.
 Taxation is the primary way that the government collects money. Taxes give the government the money
it needs to operate.
 The attributes of a good tax system are:
o Fairness/Impartiality
o Equality/equitable
o Adequacy
o Simplicity and Certainty
o Transparency
o Consistent
o Convenience
o Efficiency
o Flexibility
o Effective

 Taxes are either proportional, progressive or regressive

 Taxes can be direct or indirect.
 Taxes are levied on individuals or organisation in order to:
o Raise revenue for government spending.
o Promote economic growth
o To promote redistribution of income and wealth.

 An increase in tax will result in the following:

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 o increased taxes on consumer goods
o decrease in disposable income
o consumer will spend less
o the economy contracts

 A decrease in tax will result in the following:

o decrease in tax on consumer goods
o more disposable income
o consumer spends more
o the economy expands
o

Key Terms
 Progressive tax - a tax that takes a larger percentage of income from high-income groups
than from low-income groups.
 Proportional tax - a tax that takes the same percentage of income from all income groups.
 Regressive tax - a tax that takes a larger percentage of income from low-income groups
than from high-income groups.
 Negative externalities/demerit goods – consumption or production of a good causes harmful effect to a
third person.
 Indirect tax – a tax on goods and services, such as GCT, collected by an intermediary e.g. the
storekeeper
 Direct tax – a tax paid directly to the government by an individual or organisation
 Revenue – money received/earned by government. These would include income tax, customs duty,
excise tax, etc.

References
Mendes, M., McLean, R. A. and Wynter, C. (2013). Essentaials of Jamaican Taxation (4th ed). CFM

Publications, Kingston: Jamaica.

Organisation for Economic Co-operation and Development (1996). Expert Group No.3 Expert Group No.3 on

Treatment of Tax Issues in the MAI

Tax Administration of Jamaica. Retrieved from https://www.jamaicatax.gov.jm/history-of-tax-administration

http://www.slideshare.net/fimportado/general-principles-of-taxation?next_slideshow=1

http://dx.doi.org/10.1787/9789264218789-5-en

http://www.economicsconcepts.com/essentials_of_a_good_tax_system.htm